Company directors and Universal Credit
This article was originally published on 13 May 2021. It was updated on 19 November 2021.
Introduction
Some self-employed people choose to set up a limited company for their business, rather than operating as a sole trader or partnership. This means that they are a separate legal entity to the company. Some limited companies will have shares and shareholders. When a person chooses to run their business in this way, it raises the question of how they are treated for the purposes of Universal Credit (UC). This can be a complicated area, so this article is intended to help advisers understand the rules.
There are provisions in the Universal Credit Regulations 2013 (“the UC Regulations”) which apply to company directors. The key provision is regulation 77, entitled “Company analogous to a partnership or one person business”. Although the title does not make it clear, regulation 77 is intended to encompass company directors:
77. — (1) Where a person stands in a position analogous to that of a sole owner or partner in relation to a company which is carrying on a trade or a property business, the person is to be treated, for the purposes of this Part, as the sole owner or partner.
In other words, if the company director is akin to a sole trader, or partner in a partnership, in relation to a company which is carrying on a trade (or a property business), they are treated as if they are a sole owner or partner. It is possible that regulation 77 will apply to other people who are not company directors but are still ‘analogous’ to sole owners or partners, however, in this article we will focus on company directors. One effect of this regulation is to ensure that there is no advantage for benefits purposes in a person creating a limited company, because UC will treat them in the same way as if they had chosen to organise their self-employment as a sole trader or partnership.
Note that regulation 77 will not apply at all if the company is not either carrying on a trade, or a property business. The meaning of a trading business is explained in Chapter H4 of the Advice for Decision Making (ADM) guidance published by the Department for Work and Pensions (DWP), at paragraph H4370. It means a business with a profit-seeking motive, regardless of whether a profit is actually made. Trading usually involves providing goods or services to customers on a commercial basis.
Income
Regulation 77 allows the income of a company to be treated as self-employed earnings where the claimant “stands in a position analogous to that of a sole trader or partner in relation to a company which is carrying on a trade or a property business”. In such cases, the claimant is treated as if they were the sole owner or partner of the company for UC purposes. The intention is to treat them the same way as a self-employed person who has not set up a company to conduct their business. Importantly, it is a question of fact in each case whether the claimant is in a position analogous to a sole owner or partner. A person who does not work for the company could still be like a sole owner or partner, for example if they have 99% of shares and total influence over the day to day running of the business. Alternatively, if they have a meaningful influence in the day to day running of a company, this could be viewed as being analogous to a partnership.
If regulation 77 applies, the total income of the company (or the person’s share of that income) is treated as the claimant’s income and calculated as if it were self-employed earnings under regulation 57. This means that the company’s income will be a ‘receipt’ into the business, from which allowable deductions for certain expenses — such as wages — can be made. The resulting figure is then added to any employed earnings they receive as a director or employee of the company, so there is no double counting. Many company directors draw a salary from the company through Pay as You Earn (PAYE) and this would typically be reported through the Real Time Information (RTI) system. Any self-employed income the claimant is treated as having under regulation 77 is taken into account along with employed earnings. The fact that the income of the company is treated in the same way as self-employed income means that the director must comply with the reporting requirements every assessment period, even if there has been nil income or a loss.
Example
David is the sole director of a small limited company which does gardening work. His assessment period (AP) runs from the 8th of each month to the 7th of the next month. On the 22nd day of each month, David pays himself a salary through PAYE of £500. In the AP from 8 June — 7 July, David reports £1,450 in income from customers and £800 in expenses. The expenses are £300 on tools and fuel, plus the £500 salary he has paid himself.
The DWP decides that David stands in a position analogous to that of a sole owner in relation to a company that is carrying on a trade. He is treated as having a 100% share of the income of the company. The DWP decides that his expenses are allowable, so can be deducted from his receipts. David will be treated as having employed earnings of £500, in addition to self-employed earnings of £650 (after deductions for tools, fuel and wages), for total earnings of £1,150.
If David was a sole trader, instead of a company director, then the gross income would be £1,450, from which he could deduct £300 in tools and fuel, leaving net self-employed income of £1,150 — the same as if he were a company director. He would be treated the same in both cases.
Company directors can be subject to the minimum income floor (MIF) if they are in gainful self employment, although there are other conditions that are necessary for the MIF to apply — see our article on the MIF and when it applies. If the MIF is applied, the claimant will have no work-related requirements. Company directors who are in gainful self-employment and who are taking steps to grow their business might benefit from a start-up period, during which the MIF is not applied.
Dividends
Many company directors draw dividends from the company. In some cases, these payments form a significant proportion of money the person draws from the company to pay their living costs. So how are dividends treated by UC?
Unfortunately, the answer is not clear. A dividend is a payment derived from ownership of shares. Therefore, it does not meet the definition of ‘earned income’ in regulation 52 of the UC Regulations, because it is not the remuneration or profits derived from employment, a trade, or paid work, nor is it treated as earned income elsewhere in the UC Regulations. A dividend is not specified ‘unearned income’ in regulation 66 either, so could not be taken into account as unearned income. Because income for UC must be either earned or unearned in order to be taken into account, this leads to the conclusion that a genuine dividend payment cannot be taken into account as income at all. However, it is possible that the dividend could be regarded as not genuine if the payment is actually derived from employment or an office, rather than solely from the ownership of shares. In such cases the dividend would be a ‘sham’. It would then be taxable as general earnings, and treated as earned income under regulation 55. The way the payments are treated by HMRC for tax purposes would be a relevant factor, but the DWP or a tribunal would need to come to their own conclusion.
A genuine dividend payment is likely to be treated as capital, although it is unclear at exactly which point it is capital. All income, including income which is ignored for UC, becomes capital if it remains unspent by the end of the assessment period after the one in which it was received. Alternatively, the dividend may be capital immediately, because one-off payments that are not made in reference to a period of time are treated as capital. This is less likely to be the case if the dividends are paid regularly or periodically.
Capital
The starting point in relation to capital is that the company director’s shareholding in the company is disregarded, but instead they are treated as possessing an amount of capital equal to their share of the value of the company. This provision is needed because company directors would otherwise not be treated as being beneficial owners of the company’s capital (paragraph H1134 of Chapter H1 of the ADM guidance). Paragraph 2 of regulation 77 provides the following:
(2) Where paragraph (1) applies, the person is to be treated, subject to paragraph (3)(a), as possessing an amount of capital equal to the value, or the person’s share of the value, of the capital of the company and the value of the person’s holding in the company is to be disregarded.
For example, if the client owns a 50% share of the company and is treated as being in a position similar to a partner in a self-employed business, then the value of their shareholding in the company is disregarded, but instead they are treated as possessing an amount of capital equal to 50% of the value of the company’s capital.
While the company director is treated as possessing the company’s capital, there are provisions under which this can be disregarded. If the person is engaged in activities in the course of the trade, then any assets of the company that are used wholly and exclusively for the purposes of the trade are disregarded as part of that person’s capital. This is under paragraph (3)(a) of regulation 77. If there is capital in the company that is not used wholly and exclusively for the purposes of the trade, it won’t come under this disregard.
This is more restrictive than the general disregard in paragraph 7 of Schedule 10 of the UC Regulations of “assets which are used wholly or mainly for the purposes of a trade, profession, or vocation which the person is carrying on”. There might be a situation when someone is not actually currently engaged in activities, but is still ‘carrying on’ that trade. Additionally, the disregard in paragraph 7 of Schedule 10 covers assets mainly used for the purposes of the trade, whereas the disregard in paragraph (3)(a) only applies to those assets used wholly and exclusively for the purposes of the trade. The more restrictive conditions in paragraph (3)(a) could suggest that if these are not met, the person wouldn’t be able to rely on the wider provisions in paragraph 7 of Schedule 10.
There is also a disregard in paragraph 8 of Schedule 10 of assets which were used wholly or mainly for the purposes of a trade that the person has ceased to carry on in the past 6 months if the person either stopped being engaged in the trade due to incapacity (and expects to re-engage on recovery) or if the person is taking reasonable steps to dispose of the assets. The period of six months can be extended where this is considered reasonable by the DWP. There is no similar provision to this for people who have stopped carrying on a trade under regulation 77(3)(a). It might be possible to argue that the disregard in paragraph 8 of Schedule 10 could still apply to someone in this position, although it would not be certain that such an argument would succeed.
Example
June and Johnny are a couple. They have a self employed business as painters and decorators. June and Johnny set up a limited company for the business, each holding a 50% share of the business. At the moment, June is engaged in activities in this business. Johnny stopped working due to an operation. Johnny is gradually getting better and expects to return to work within the next 3–6 months.
June is treated as being in a position similar to that of a partner in a business, so her shareholding in the company is disregarded, but she is treated as possessing capital equal to the value of 50% of the company’s capital. As June is currently engaged in activities in the course of the trade, the business assets can be disregarded from being treated as part of her capital.
Johnny is also treated as being in a position similar to that of a partner in a business, so his shareholding in the company is disregarded, but he is likewise treated as possessing capital equal to the value of 50% of the company’s capital. Johnny is not engaged in activities in the course of the trade, so the business assets cannot be disregarded from being treated as part of his capital under regulation 77(3)(a). However, Johnny might be able to argue that the disregard in paragraph 8 of Schedule 10 applies as they ceased carrying on the trade due to incapacity and expect to be reengaged on recovery. If their recovery takes longer than 6 months, it may be possible to extend the disregard further if the DWP agrees that this is reasonable, under regulation 48(2) of the UC Regulations.
The situation is different if someone is not treated as being in a position analogous to that of a sole trade or partner. In this case, a client would not be treated as possessing a share of the company’s capital at all (paragraph H1132 of Chapter H1 of the ADM guidance states that “directors of the company are not the beneficial owners of the capital of the company.”). However, if the client has shares in the company that they are the beneficial owner of, the value of the shares themselves would be taken into account in working out their capital (paragraph H1134 of Chapter H1 of the ADM guidance). There is guidance in paragraphs H1679 to H1681 on valuing shares in a private company, including which factors need to be taken into account, such as whether there is anything in the articles of association restricting the sale of the shares.
Conclusion
The treatment of company directors in universal credit is a complicated area. This article has discussed the rules which determine how their income and capital is taken into account.
Citizens Advisers can contact the Expert Advice Team for help with individual issues.
Josh Gilbert and Lawrence Barratt work in the Expert Advice Team at Citizens Advice.
The information in this article is correct as of the date of publication.
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